130 F.2d 141 | 2d Cir. | 1942
Lead Opinion
The question presented is whether a Chilean corporation realized taxable income by purchasing in the United States some of its own debenture bonds at less than their face value. The taxpayer contends, first, that the unusual circumstances under which its debentures were issued, and the limitations upon liability which they contained precluded its realization of gain by their purchase; second, that if gain was realized, it was not “income from sources within the United States,” which alone is taxable under section 231 of the
The case was tried upon stipulated facts which the Board summarized in its opinion so far as it considered them material. They are very complex and so unusual that our decision can be of little interest except to the immediate parties to the litigation. Therefore our discussion will for the most part assume familiarity with the facts and a brief statement will suffice for this opinion.
The taxpayer was created in 1934 by Law 5350 of the Republic of Chile. It was granted a monopoly for a period not exceeding 35 years of the exportation of and trade in nitrate and iodine in Chile. Its principal office is in Santiago; it has never maintained an office or place of business in the United States. Its books are kept and its tax returns filed on the accrual basis of accounting, and its fiscal year ends June 30th. Prior to the creation of the taxpayer the nitrate industry in Chile had been in the control of another Chilean corporation known as Cosach. In 1933 a presidential decree declared that Cosach had been illegally organized and operated and ordered its liquidation by commission. A moratorium against the collection of its bonds and other obligations was also established. Pursuant to Law 5350, under which the taxpayer was organized, the liquidation commission returned to the former shareholders of Anglo-Chilena and Lautaro, the two principal producers of nitrate in Chile, the capital stock which Cosach had acquired and transferred to a corporation called Antofagasta the nitrate lands and other assets acquired from some thirty “independent” producers. They and their creditors received the shares and securities of Antofagasta. This disposed of all the assets of Cosach except the stocks of nitrate and iodine on hand as of June 30, 1933. These were transferred to the taxpayer upon its organization in January 1934. Exclusive of its bond issues hereafter to be mentioned, the obligations of Cosach which the taxpayer was obliged to assume under Law 5350 equalled or exceeded the value of such nitrate and iodine stocks. Cosach had outstanding an American issue of 7 per cent, bonds in the principal amount of some $38,000,000 and a British issue in the principal amount of some £2,700,000. Law 5350 authorized the taxpayer to issue its 5 per cent, debentures in exchange for Cosach 7 per cent, bonds which were then to be can-celled. All but $492,000 of the American issue were so exchanged. The taxpayer’s dollar debentures were issued under an indenture to the Guaranty Trust Company of New York as trustee. The liability of the taxpayer was strictly limited by the provisions of Law 5350. Thus it was under no obligation to pay either interest of principal of the debentures unless it had net earnings sufficient for that purpose. By the provisions of Law 5350 its net earnings were to be used as follows: 25% to the Chilean Government as the price of the granted monopoly; out of the remaining 75% a sum equal to 6 per cent, on the exchanged Cosach bonds was to be devoted to interest on and amortization of the debentures, and a like sum paid to the producers; thén 30% of the balance, if any, was to be devoted to “extraordinary amortization” and 70% paid to the producers. Upon dissolution of the taxpayer or upon maturity of the debentures and default by the taxpayer, unconditional liability for principal and interest thereof was assumed by Cosach in liquidation, Anglo-Chilena, Lautaro and Antofagasta, the three last named corporations having “adhered” to the taxpayer pursuant to Article IV of Law 5350 early in 1934. The trust indenture provided that the debentures might be redeemed at specified premiums and that after the deposit of redemption funds with the trustee, the taxpayer might purchase debentures on the market and obtain from the trustee reimbursement for their cost. During the taxable year in suit the taxpayer purchased in the United States debentures of the face value of $189,000 for $102,881.25 and was reimbursed therefor by the trustee out of the redemption fund. The commissioner determined that the difference of $86,118.75 constituted income to the taxpayer from sources within the United States; accordingly he assessed the deficiency in dispute. See Art. 22(a)-18, Treas.Reg. 86.
It is authoritatively established that a corporation may realize taxable income when it purchases its own bonds at less than the price at which they were issued.
The taxpayer contends that the Kirby principle is inapplicable to the case at bar because (1) it received no money or property as consideration for issuance of its debentures, and (2) extinguishment of the debentures did not free its assets from a fixed liability to which they were theretofore subject, since its obligation was wholly contingent upon future earnings. As to the first objection, the Board held that the issuance of the debentures was not gratuitous; it treated the monopoly granted to the taxpayer as consideration for its debentures, as well as for its annual payments to the government, and found that the monopoly had “great value” as demonstrated by the taxpayer’s profits of $5,-000,000 in 1934 and $9,000,000 in 1935. There was no finding, however, as to the amount of its value. Whether the Board’s decision could be sustained without a finding that the monopoly was worth as much as the face of the taxpayer’s debentures, some $50,000,000, is perhaps doubtful. But without decision of that question we shall pass to the taxpayer’s second objection, based on the contingent nature of its liability.
If the cancellation of indebtedness results in income on the theory that thereby assets are freed for the debtor’s general use, it appears self-evident that the obligation to be retired must be one which unconditionally subjects the obligor’s assets to liability for the payment of a fixed amount. If A covenants under seal to pay B half of next year’s business profits and later pays B $1,000 for release of the covenant, it is obviously impossible to tell immediately whether the transaction was profitable or the reverse. If next year’s profits should be less than $2,000, A will have lost money by his purchase of the release; on the other hand, should the profits be large he will have gained, but how much cannot be known until next year’s business has been concluded, although it might be possible to make an approximate estimate in advance based on past experience. Moreover, the release of A’s covenant could not possibly free capital assets from a preexisting liability (as in the Kirby case) for the covenant created no charge upon his capital assets. Likewise is this true in the case at bar, since the debentures were payable only out of a certain percentage of profits, if earned. The Board treated this fact as immaterial; it measured the taxpayer’s gain as though it were absolutely liable to pay the face value of each $1,000 debenture. Yet there was no finding that its future earnings would be suificient to make such payment upon the maturity of the debentures in 1968 (or the earlier dissolution of the taxpayer) ; nor was there any evidence upon which such a finding could have been made. Whether the taxpayer made a profit or loss in buying up debentures at 45% discount from face value is as yet pure speculation. We are satisfied, therefore, that the decision cannot stand unless the liability of the parties who are unconditionally bound to pay the debentures, if the taxpayer does not, can be availed of by the government to support the tax.
The taxpayer is an unusual corporation in many respects; one is that it has no shareholders. The distribution of its profits is prescribed by the law of its creation and the beneficiaries of such profits as are not allocated to the Chilean Government and the “servicing” of the corporation’s debentures are the “adhering” producers. Anglo-Chilena, Lautaro and Antofagasta have “adhered”; whether there are other adhering producers does not appear.. For purposes of discussion let it be assumed that the three named are the only adherents and may be regarded as shareholders. The case then becomes one in which the corporation is contingently liable and its only shareholders are absolutely bound to pay the debentures, if it does not. In such a case, purchase by the corporation of its debentures frees assets of the shareholders
For the foregoing reasons we think the tax cannot be sustained, and it becomes unnecessary to consider the other contentions of the petitioner.
Order reversed.
Dissenting Opinion
(dissenting).
There can be no doubt that somebody made a profit when the bonds were bought in at a discount; and I think that that'profit was made “from sources within the United States.” § 119(a) of the Revenue Act of 1934, 26 U.S.C.A. Int.Rev.Acts, page 709. If a non-resident obligor makes a bond payable in this country, he must bring his funds into the country to pay it; if he buys it in at a discount, that may not relieve any of his assets then within the United States, but it does relieve him of the duty of bringing assets into the United States when the bond falls due. There seems to me to be no substantial difference between that and relieving assets already within the United States. It does not of course follow that the taxpayer at bar should be taxed as though this profit were its own, and I feel the force of my brothers’ reasoning to the contrary. I assume—because the taxpayer has the burden of showing the contrary—that the only persons who had any interest in its assets were the four “adherents”—“Cosach in Liquidation,” Antofagasta, Lautaro and Anglo-Chilena. The taxpayer’s obligation, though it was in form to pay the principal and interest of the bonds, was so limited that the burden of it could not be appraised, and there is no basis for estimating its profit unless we may look to the assets and undertakings of the “adherents” and treat them and the taxpayer as one.
The relations between them were that the taxpayer collected the earnings, paid the royalty to the Chilean government and distributed the surplus to the four “adherents” in proportions which varied from year to year. It had promised to pay the bonds only to the extent of the earnings; but the “adherents” promised without limitation to pay them so far as the taxpayer did not; and that promise was joint and several. The situation therefore was that any payments made by the taxpayer relieved the “adherents’ ” general assets quite as much as though they paid themselves, and that the payments came out of earnings which would otherwise be distributed to them. But we can tell neither how the earnings would be distributed, nor how the eventual burden of the bonds would have been distributed, even though